Three Waters: Councils will never have control over water entities

The control of $35 billion worth of crucial New Zealand water assets will be determined by three of the most boring words in the English language: balance sheet separation.

Balance sheet separation isn’t likely to knock other eye-catching triple worders off the front page – certainly not in the age of the “deadly global pandemic”, but those three words are nevertheless important and here’s why:

Water assets – that’s everything from pipes to reservoirs and treatment plants – are owned by 67 councils up and down the country. The Government has decided to effectively confiscate those assets and put them into four large water entities.

The reason: councils have been underinvesting in water for decades, leaving places like Havelock North with undrinkable (even deadly) drinking water, and places like Wellington with sewage running down the street.

Local Government Minister Nanaia Mahuta has gone to war with councils over the reforms. Initially, she had said the changes would effectively be voluntary. She’s now given up on that approach, deciding to take the assets by force.

The sticking point is governance. Technically, councils will still own their assets, because they will have an ownership stake (although not a shareholding) in the water entity to which their pipes now belong.

But what councils really want to know is if that ownership stake will translate into control over decisions made about those assets. The answer to that is a resounding “no” – and it’s meant to be that way.

Under the most recent governance proposal, a “Regional Representative Group”, made up of local authority members and mana whenua, will vote on appointing an independent panel, and that panel will itself appoint board members to govern the local three waters entity.

This gives councils almost no control over the board of the entity, which it is two steps removed from.

Councils are understandably incensed – and the Government has tried to allay their concerns by deciding to create a new working group which will finalise the details of how the entities will be governed – this will answer the question of who has ultimate control of the pipes.

Councils shouldn’t get their hopes up – their distance from the governance of the water entities isn’t a bug, it’s a feature.

In order to front up with the $120 billion to $185b investment in water that modellers estimate will be needed over the next three decades, the new water entities will need access to massive amounts of borrowing.

International ratings agencies, the people who rate the quality of debt, which determines the cost of borrowing, could be sceptical that these new water entities are anything more than councils in disguise.

This would mean the water entities would pay more to borrow, and both councils and water entities wouldn’t be able to borrow the money they need to make the water reforms work in the first place.

To get around this, the Government invited one of the ratings agencies, Standard & Poor’s to give its advice on how both councils and the water entities could borrow money independently of one another. What the debt market wants is those three words – “balance sheet separation” – and what this translates to is a design that ensures that councils have almost no control over the water entities.

Any system that proposes more control ceded to councils will compromise that balance sheet separation and will, by extension, undermine the whole reason for upending water in the first place: being able to borrow and invest in new water pipes.

Councils that hope for any greater control will inevitably be disappointed: lack of control of the point.

Politics of centralisation

The politics of the decision will play out at a national and local level, particularly in the run-up to next year’s local body elections.

The Government is right to say councils have not invested sufficiently in water – councils are equally right to push back and say they’ve never really had the means to do so.

The truth is somewhere in between; while many councils have displayed poor governance, they haven’t been helped by central government’s insistence that councils should have absolutely no access to the kinds of revenue and debt tools they need. Councils know it’s difficult to invest money they don’t have.

Three Waters in this sense is just an expression of the chicken-and-egg question that haunts all central government decisions about local government: is local government bad because it’s funded so poorly, or is local government funded poorly because it’s so bad.

National and Act have promised to reverse any changes, with National saying it will take its own three waters policy to the next election.

Currently, National is comfortable with one prong of the Government’s reforms: the creation of a new water regulator, which will set and enforce minimum standards for water (drinking water regulation had previously been done by the Ministry of Health).

Where National doesn’t have a plan is for how councils will get the funding they need to be able to live up to these new high standards.

Just what level of funding is necessary is an open question. The Government’s modelling suggests water needs a level of investment councils could not possibly afford.

But other modelling, commissioned by councils, suggests otherwise. They think, with some help, they could eventually manage the water assets on their own.

Councils have been on their best behaviour, lifting their investment in water. Historic council capital expenditure in water has been about $1.5b annually over the last 5 years. But as of last year, draft long-term plans for 2021-31 saw that investment nearly doubling to about $2.7b annually. Councils appear to have got the message.

The big political question is what happens at the local level: Left-aligned mayors and councillors are in the ascendant in our biggest cities. Labour-aligned councillors with an eye on a seat in Parliament will face a difficult choice between backing concerns of constituents now at the risk of aggravating the party that they hope will eventually send them to Parliament.

Cabinet will have to repair relationships too: councils have every reason to be furious at the Mahuta.

Having previously said the reforms would be essentially voluntary, the Government changed its mind and made the changes compulsory when it realised it wouldn’t get its way. Future negotiations with councils are likely to be tainted with the knowledge that the Government isn’t coming to the table in good faith.

Councils are also frustrated with other policy areas like planning, which are being centralised. Instead of working with councils on how they could do their job better, the Government has decided it would be better if councils were relieved of the need to do any job at all.

In fact, the Government’s centralisation of water and planning – two of councils’ main jobs – brought on something of an existential crisis in local government, with councillors wondering what the government would centralise next.

That crisis had led to one of the only things councils are currently happy about: a review of what local government will look like in the future, and how it will be paid for.

This provides an opportunity for Mahuta to make amends with councils by working with them to figure out what councils can do (and do well) in coming decades.

And make now mistake, amends will need to be made. The Government has big ambitions in housing, transport and climate change.

If it wants to solve any of them it will need councils, particularly those of our main centres, onside. It will be very difficult to do that while spending every day from now until 2024 fighting over who controls the pipes.

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